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Seed Weekly - The Case for Offshore Wrappers

A couple of years ago I wrote an article explaining the benefits of using an endowment when structuring local investments.

In this article I want to look at the benefits of using a “wrapper” when structuring your offshore investments. Whilst the following list is not exhaustive, these are the main reasons why one should use a wrapper when investing offshore:

Succession planning

• Most wrappers are usually held in the name of both spouses so when one spouse passes away the other spouse automatically becomes the sole owner of the investment.
• Most companies also make provision for secondary beneficiaries or alternative beneficiaries which come in to play at the passing of the surviving spouse. Depending on the company these beneficiaries can then continue with the investment (they will however have to pay Estate Duty).
• Because of the structure of the wrapper, there are no probate issues involving expensive lawyers, reams of paper work and huge amounts of time.
• Because the transfer of ownership happens outside of the Estate, no executors fees are payable on the investment.

Tax savings

• High nett worth SA individuals pay 45% income tax and presently pay 18% Capital Gains tax. When using the wrapper income tax of 30% and CGT of 12% is payable within the policy.
• The use of roll up funds negates the income tax implications of offshore investments.

The graph below illustrates the effect of the points above :

Ease of administration

• When dealing with a wrapper no matter how many underlying products you have you only deal with one statement.
• All income tax implications are dealt with by the wrapper, as the owner of a wrapper your only duty is to disclose the value of the wrapper in your statement of assets and liabilities.

Situs

• With the Situs legislation, US and UK assets over certain thresholds are deemed to be Estate dutiable in the US/UK. Estate duty in the US and UK is 40% and not the 20% that we pay in South Africa. The domicilium of the wrapper means that US and UK registered unit trusts and shares do not fall within the grasp of the Situs legislation

So whilst it is slightly more expensive to use a wrapper rather than a direct investment, I feel that the benefits far outweigh the small additional costs of the structure.

Seed Weekly - Being a Peeking Tom - and what you stand to gain

Being a successful investor requires the right mindset, specifically the ability to apply long term thinking to situations where the practicalities of everyday life do not make this an easy task. It requires remaining focused on an end-goal, one which most often seems intangible and a long way into the future, all whilst the world around you keeps growing and evolving, appearing much more tangible than the end-goal.

As an investor, part of the ongoing challenge is disassociating yourself from the avalanche of information at your disposal, which may lead you astray and ultimately detract from your end-goal. The solution does not lie in the avoidance of information, but rather in correctly categorising and processing the information that you absorb. Many times, the information presented to you creates the impression that immediate action is required in order to see yourself through.

Managing this challenge can be very tricky, as it is not always clear at the time whether taking action will increase the probability of achieving certain long-term goals, or have the opposite effect altogether. Doing nothing can be the hardest (in)action to take at times.

However, our job is to advise no action be taken about as often as recommending a certain course of action. This should be considered in context. Our job is not to react to every piece of information that becomes available. Our job, in this area, is to ensure that your investment assets are suitably positioned in order to maximise the probability that your long-term goals are met.

We know that an immediate reaction will often times only take into consideration the latest data point in a long series of data points, so to speak. Following this logic is a good way to reduce the probability of achieving the end-goal of any investor.

While this may seem like an indictment of the world around us, we by no means want people to live in isolation from information. Missing data points can also cause a skew in the way that you perceive situations.

It takes time to build towards the achievement of a goal, and attempting to measure the success of a certain investment strategy too frequently may not be the best way to go about it. It is thus important not to peek too often, not every peek will show a peak.

There is positive and negative information presented to us each day, but not all of this information will prove material in the bigger scheme of things. We have to correctly and holistically place the information we receive into the bigger picture, and make our decisions from there. As the old saying goes, “You can’t see the forest for the trees”. Sometimes, you need to take a step back.

To us it is far more important to be purposeful in the actions that you take than to be industrious, and constantly making changes to your investment portfolio. In fact, too much action may, if nothing else, increase “friction” (time out of the market, transaction costs and early realisation of capital gains tax) and dampen your long-term investment success. These are best left delayed, as you can earn “opportunity income” on the assets that would otherwise have been used to settle these expenses.

Our philosophy has always been one of long-term investing and thinking. Our discipline is living by this philosophy. Before we take any action, we ask ourselves whether this will help our clients reach their goals. Based on this answer, we either take the next step or go back to the drawing board.

Kind regards,

Stefan Keeve

***SEED IS HIRING: Seed is looking to hire a Financial Manager with Business Operations Oversight to the Seed Group of Companies. Please click here to view vacancy.

Seed Weekly - Investment Decisions in Good Times

Sir John Templeton, the great investor and philanthropist, once said that “the time to reflect on your investing methods is when you are most successful, not when you are making the most mistakes”. This reminds me of the Sigmoid Curve, a mathematical function, commonly applied to business and other activities in life. The curve is used to describe the story of a product’s life cycle, the rise and fall of corporations, and can be extended to personal life, for example describing the course of love and relationships (Charles Handy, 1994).

Sigmoid Curve

Source: Seed Investments Research (5 September 2017)

The curve represents time on the horizontal axis and activity on the vertical axis. There is an initial development stage starting slowly, experimenting and faltering before growing until eventually petering out. Charles Handy pointed out that the key to constant growth is through starting a second curve at point A (good times), where there is time, energy and resources to get the new curve through its initial explorations and floundering before the first curve begins to dip downwards. Although this seems obvious, the message coming across at point A is that all is well and therefore why change a winning formula? Experience tells that the real energy for change comes when one is staring disaster in the face, represented by point B on the curve.

The Curve in Investing

The shape of the curve is not new in investments, and is commonly used to illustrate when to buy or sell assets. The investment philosophy at Seed is to take a long term view. Strategy selection within the funds is guided by the structured investment process, including strategic and tactical asset allocation. It is easier to contemplate changes when something is not working rather than when it is.
Furthermore, looking at the Sigmoid Curve, aside from the concept of taking profit, it seems paradoxical to think long term (buy & hold) and change (point A on curve), particularly because at this point, things are going well.

Seed Balanced Fund

Although manager/strategy decisions are made as per our investment process, I carried out an exercise to check at which point on the curve these decisions are made, good or bad times. The chart below illustrates points at which new strategies have been added to the Seed Balanced Fund in relation to the quartile performance of the fund on a rolling 3 year basis. The fund has been in the top or second quartile 92% of the time, outperforming the peer group average across all periods and the CPI + 6% return target, 76% of the time. In general, the additions are predominantly during periods of good performance.

Arrows represent points at which new strategies have been added to the fund (global property, local high yield property, African equity, China equity, local equity, offshore equity and credit)

Source: Seed Research & Morningstar Direct (5 September 2017)

I juxtaposed the same analysis on a shorter-term chart (rolling 1 year) being more volatile and potentially more informative with respect to current experience. The fund outperforms the peer average 71% of the time and the return target 55% of the time. The results are consistent with those above. However, the most recent strategy changes in 2016 only occurred after a period of outperformance (point B – hopefully, lesson learnt. Fortunately, the upswing came shortly after).

Seed’s decision making continues to follow a structured investment process. To stay ahead, it is important to remain cognisant of the fact that it is just as important to reflect on investments in good times just as it is naturally easy to reflect during tough times.

Kind regards,

Tawanda Mushore

***SEED IS HIRING: Seed is looking to hire a Financial Manager with Business Operations Oversight to the Seed Group of Companies. Please click here to view vacancy.

Seed Weekly - Is Index Investing the same as Passive Investing?

Many column inches have been dedicated to the positives and pitfalls of passive over active investing. At Seed Investments, we take an active (excuse the pun) interest in the discussion, but ultimately seek to provide our clients with the best (after cost) risk adjusted returns irrespective of how they are delivered. As multi-managers, we don’t prefer one over the other, but by understanding the pros and cons of each we’re able to design our Funds using the best of both.

One commonality between the two has been the explosion of options over the past 5 – 10 years, and we therefore think it is even more important than ever before for investors to engage with an organisation that has expertise across the range of passive and active investment options. Today we’re going to focus on index selection.

The origin of passive investing was the desire to gain access to a specific market (generally defined as the market cap index) as cheaply as possible. The S&P500 or JSE ALSI Top 40 are the indices that US or South African passive investors (respectively) would track to get the market return as efficiently as possible. Simple choice.

As passive investing has gained traction, so product providers have sought ways to differentiate themselves. One of the ways of doing this is to create new indices that give investors exposure to something that is ‘different’ from the boring, vanilla market cap index. While this is great in that it provides investors with greater choice, it also provides an additional layer of complexity and more of the burden shifts across to the investor to choose the correct index. Passive investing (i.e. not making investment decisions bar wanting market exposure) has changed to index investing. Investors now need to understand how each index is constructed.

In the local context, I took a quick look at the number of indices that give broad market exposure (i.e. not sector indices) to the bigger companies listed on the JSE (majority of exposure to Top 100 companies by market cap). For this illustration, I have only taken indices with a track record of longer than 5 years. I found 20 such listed indices that meet the above criteria (there are no doubt many more unlisted/proprietary indices excluded from this list). While the indices don’t all necessarily have an investment vehicle that tracks them, there is nothing stopping them from being tracked (and some of the indices have numerous vehicles tracking them – meaning the investor needs to decide which product provider is the best at tracking).

Essentially there are currently 20 separate ways to arrange these +- 100 shares. Over the 5-year period 31 July 2012 – 31 July 2017 the annual returns ranged from less than 5% pa to over 16% pa, with annualised volatility ranging from under 10% pa to over 17% pa. You will no doubt agree that it is impossible to lump these experiences into a homogenous group, yet the uninformed investor would find it difficult to explain why there are differences in the returns of indices that are essentially fishing in the same pool of shares.

Source: MoneyMate 31 July 2017

South Africa is a laggard in the global shift to index/passive/low cost investing and it therefore isn’t surprising to see that there has been a greater proliferation of indices in the USA. What did shock me, however, was just how pervasive it has been! The chart below shows just how extreme the ‘rise of the index’ has been in the past 10 years or so. There are now more indices to choose from than number of shares in the USA!

At Seed we are constantly looking at how indices are constructed in an attempt to understand which will be the best to track. Once we’ve determined the index that we wish to track we then investigate which provider is able to best track that index (again there are numerous techniques that managers use to optimise their portfolios) before making an allocation to an index tracking product.

I hope that I have been able to show how a simple concept (passive investing) is no longer a simple past time. Passive investing is no longer a passive process. However, putting your head in the sand isn’t a solution. You need to partner with someone who has expertise in analysing the construction techniques of a variety of indices, and who doesn’t have a vested interest in offering one solution over another. As independent multi-managers, Seed can construct Funds taking the best that active and index investing have to offer.

Seed Weekly - Is Index Investing the same as Passive Investing?

Many column inches have been dedicated to the positives and pitfalls of passive over active investing. At Seed Investments, we take an active (excuse the pun) interest in the discussion, but ultimately seek to provide our clients with the best (after cost) risk adjusted returns irrespective of how they are delivered. As multi-managers, we don’t prefer one over the other, but by understanding the pros and cons of each we’re able to design our Funds using the best of both.

One commonality between the two has been the explosion of options over the past 5 – 10 years, and we therefore think it is even more important than ever before for investors to engage with an organisation that has expertise across the range of passive and active investment options. Today we’re going to focus on index selection.

The origin of passive investing was the desire to gain access to a specific market (generally defined as the market cap index) as cheaply as possible. The S&P500 or JSE ALSI Top 40 are the indices that US or South African passive investors (respectively) would track to get the market return as efficiently as possible. Simple choice.

As passive investing has gained traction, so product providers have sought ways to differentiate themselves. One of the ways of doing this is to create new indices that give investors exposure to something that is ‘different’ from the boring, vanilla market cap index. While this is great in that it provides investors with greater choice, it also provides an additional layer of complexity and more of the burden shifts across to the investor to choose the correct index. Passive investing (i.e. not making investment decisions bar wanting market exposure) has changed to index investing. Investors now need to understand how each index is constructed.

In the local context, I took a quick look at the number of indices that give broad market exposure (i.e. not sector indices) to the bigger companies listed on the JSE (majority of exposure to Top 100 companies by market cap). For this illustration, I have only taken indices with a track record of longer than 5 years. I found 20 such listed indices that meet the above criteria (there are no doubt many more unlisted/proprietary indices excluded from this list). While the indices don’t all necessarily have an investment vehicle that tracks them, there is nothing stopping them from being tracked (and some of the indices have numerous vehicles tracking them – meaning the investor needs to decide which product provider is the best at tracking).

Essentially there are currently 20 separate ways to arrange these +- 100 shares. Over the 5-year period 31 July 2012 – 31 July 2017 the annual returns ranged from less than 5% pa to over 16% pa, with annualised volatility ranging from under 10% pa to over 17% pa. You will no doubt agree that it is impossible to lump these experiences into a homogenous group, yet the uninformed investor would find it difficult to explain why there are differences in the returns of indices that are essentially fishing in the same pool of shares.

Source: MoneyMate 31 July 2017

South Africa is a laggard in the global shift to index/passive/low cost investing and it therefore isn’t surprising to see that there has been a greater proliferation of indices in the USA. What did shock me, however, was just how pervasive it has been! The chart below shows just how extreme the ‘rise of the index’ has been in the past 10 years or so. There are now more indices to choose from than number of shares in the USA!

At Seed we are constantly looking at how indices are constructed in an attempt to understand which will be the best to track. Once we’ve determined the index that we wish to track we then investigate which provider is able to best track that index (again there are numerous techniques that managers use to optimise their portfolios) before making an allocation to an index tracking product.

I hope that I have been able to show how a simple concept (passive investing) is no longer a simple past time. Passive investing is no longer a passive process. However, putting your head in the sand isn’t a solution. You need to partner with someone who has expertise in analysing the construction techniques of a variety of indices, and who doesn’t have a vested interest in offering one solution over another. As independent multi-managers, Seed can construct Funds taking the best that active and index investing have to offer.

Is Index Investing the same as Passive Investing?

Many column inches have been dedicated to the positives and pitfalls of passive over active investing. At Seed Investments, we take an active (excuse the pun) interest in the discussion, but ultimately seek to provide our clients with the best (after cost) risk adjusted returns irrespective of how they are delivered. As multi-managers, we don’t prefer one over the other, but by understanding the pros and cons of each we’re able to design our Funds using the best of both.

One commonality between the two has been the explosion of options over the past 5 – 10 years, and we therefore think it is even more important than ever before for investors to engage with an organisation that has expertise across the range of passive and active investment options. Today we’re going to focus on index selection.

The origin of passive investing was the desire to gain access to a specific market (generally defined as the market cap index) as cheaply as possible. The S&P500 or JSE ALSI Top 40 are the indices that US or South African passive investors (respectively) would track to get the market return as efficiently as possible. Simple choice.

As passive investing has gained traction, so product providers have sought ways to differentiate themselves. One of the ways of doing this is to create new indices that give investors exposure to something that is ‘different’ from the boring, vanilla market cap index. While this is great in that it provides investors with greater choice, it also provides an additional layer of complexity and more of the burden shifts across to the investor to choose the correct index. Passive investing (i.e. not making investment decisions bar wanting market exposure) has changed to index investing. Investors now need to understand how each index is constructed.

In the local context, I took a quick look at the number of indices that give broad market exposure (i.e. not sector indices) to the bigger companies listed on the JSE (majority of exposure to Top 100 companies by market cap). For this illustration, I have only taken indices with a track record of longer than 5 years. I found 20 such listed indices that meet the above criteria (there are no doubt many more unlisted/proprietary indices excluded from this list). While the indices don’t all necessarily have an investment vehicle that tracks them, there is nothing stopping them from being tracked (and some of the indices have numerous vehicles tracking them – meaning the investor needs to decide which product provider is the best at tracking).

Essentially there are currently 20 separate ways to arrange these +- 100 shares. Over the 5-year period 31 July 2012 – 31 July 2017 the annual returns ranged from less than 5% pa to over 16% pa, with annualised volatility ranging from under 10% pa to over 17% pa. You will no doubt agree that it is impossible to lump these experiences into a homogenous group, yet the uninformed investor would find it difficult to explain why there are differences in the returns of indices that are essentially fishing in the same pool of shares.

Source: MoneyMate 31 July 2017

South Africa is a laggard in the global shift to index/passive/low cost investing and it therefore isn’t surprising to see that there has been a greater proliferation of indices in the USA. What did shock me, however, was just how pervasive it has been! The chart below shows just how extreme the ‘rise of the index’ has been in the past 10 years or so. There are now more indices to choose from than number of shares in the USA!

At Seed we are constantly looking at how indices are constructed in an attempt to understand which will be the best to track. Once we’ve determined the index that we wish to track we then investigate which provider is able to best track that index (again there are numerous techniques that managers use to optimise their portfolios) before making an allocation to an index tracking product.

I hope that I have been able to show how a simple concept (passive investing) is no longer a simple past time. Passive investing is no longer a passive process. However, putting your head in the sand isn’t a solution. You need to partner with someone who has expertise in analysing the construction techniques of a variety of indices, and who doesn’t have a vested interest in offering one solution over another. As independent multi-managers, Seed can construct Funds taking the best that active and index investing have to offer.

Seed Weekly - Investment Returns from Local Shares

Half way through the calendar 2017 is a good time to take stock of what investments have produced – not only for the 6 months – but for longer periods of time as well.

It would be fair to say that investors into the local equity market have been disappointed now for at least two to three years, where both the rolling annual returns, and the compounded 3 year return, is far lower than what investors have become accustomed to. Below are a few of the numbers for clarification purposes:

• The JSE All Share index up 3.4% for the 6 months to June 2017
• Over the last 3 years, this index has compounded at the same level at 3.4% per annum
• The Top 40 index fared slightly worse at just 2.5% per annum
• The Resource index has had a torrid time, declining by 15.4% per annum over 3 years
• Industrials, the best performing main sector, has also only returned 7.6% over the 3 years (annualised)

Naturally, these returns are far less than what investors have come to expect, and also relative to expectations, given the risk levels. As mentioned above, the total return from an investment into the JSE All Share index has now compounded by only 3.4% per annum over the last 3 years – very poor when compared against a relatively lower risk investment of money in the bank.

One concern we have regarding the sideways price movement over the last 3 years, is that it has not been accompanied by an improvement in valuations. Typically, there is an improvement in valuations as prices fall or move sideways. However, when we measure current valuations compared to long term valuations, they remain on the expensive side.

On a positive note, one of the factors that has put pressure on the JSE All Share index over the last 18 months has been the firmer rand, which, from closing at R15.86/USD at its weak point in January 2016 has strengthened to its current level around R13/USD. As 50% - 60% of the JSE All Share is rand hedged, this headwind has the potential to turn into a tailwind, should we see rand weakness from this level out.

Chart 1 (below) reflects the annual total return from an investment into the JSE as measured by the JSE All Share index. Since 1986, the 12 month return has varied from a positive 80% to a negative 37% as measured on month end prices. Clearly, there is huge volatility in the 12 month total return that an investor experiences on the local stock market.

Chart 2 (below) compounds up these returns from January 2003. Even with the large 2008 sell off in the global financial crisis, prices have moved up on average by approximately 15% per annum from the base in 2003. When taking into account dividends, the total annual return for this period came in at 18.4% per annum. Extending that for the poor performance over the last 3 years has now reduced that compounded return to 15.9%.

Chart 1 : FTSE/JSE All Share total annual return

Sources : Inet, Seed Investments (30 June 2017)

Chart 2 : FTSE/JSE All Share Index Price Return

Sources : Inet, Seed Investments (30 June 2017)

In conclusion, given the range of issues that has concerned the rating agencies resulting in downgrades, it would be fair to say that the risks of investing in South Africa have generally increased. Therefore, investors should demand a higher required rate of return. Over the long period of history, investors have been rewarded with higher returns, but as illustrated in the charts above, this return is never achieved linearly.

Seed Weekly - Investor Returns and the Cost of Timing the Market

The current investment environment provides a test of patience for investors, particularly when one is not prepared for periods of underperformance. It is normal for funds to underperform as performance goes through cycles. Knee-jerk reactions fuelled by emotions of fear and greed often result in investors not achieving the full investment cycle returns from the funds they invest in.

Fund total returns widely published by independent data providers on fund manager websites and marketing materials reflect a buy-and-hold strategy over the investment period. However, some investors, because of fear and greed, do not follow this strategy, but rather attempt to time the market, selling underperforming funds and buying those that are outperforming. This behaviour can be harmful, particularly if investing in a fund that has already reached the peak of its performance cycle. Chart 1 (below) illustrates such investor behaviour, and Chart 2 illustrates the cost of trying to time the market.

Fund A is a South African Multi-Asset High Equity Fund. Inflows and outflows are closely linked to the short-term performance illustrated by the 1 year rolling return quartile rank.
Source: Morningstar Direct (10 July 2017)

Chart 2: Investor Behaviour – The Cost of Chasing Performance
Switching from High Equity to Low Equity During Period of Underperformance

Leading up to February 2009, the Multi-Asset High Equity Category fell -15% compared to the Low Equities -1%. A switch at the time to the Low Equity to minimise losses would have seen a subsequent 3 year cumulative return 16% lower in the Low Equity Category.
Source: Morningstar Direct (10 July 2017)

Since cash flows result in a different experience for the investor compared to the actual fund total return, a dollar-weighted return (investor return) gives a better indication of how the average investor performs over time. When the investor return is lower than the fund total return, it implies that more investors participated in downside returns and less in upside returns. This is common when investors chase returns and pile flows into funds at the peak of their performance and can also be exacerbated by not selling a losing fund. Investor returns are greater than total returns when there is more upside participation by investors.

A global report published by Morningstar showed a 5 Year return gap between investor and total returns up to the end of December 2016 ranging from -1.43% to +0.53% (negative indicates lower investor returns). Results from the US and Europe where data sets are more reliable show the challenges that investors face because of the unfortunate timing of cash flows, generally resulting in lower investor returns. The more volatile Funds and higher cost funds tend to have the larger return gaps. A sample of local funds in the Multi-Asset categories over a 5 Year period gives a mixed bag of results as shown below. Wide negative return gaps on some funds illustrate how investors lose out in comparison to overall fund returns.

Chart 3: Selected Large South African Multi-Asset Fund Investor Returns Compared to Total Returns
Difference Between Investor and Fund Total Returns (%)
5 Year Local Multi Asset Fund Returns

Source: Morningstar Direct (10 July 2017)

It is key for investors to select appropriate funds aligned with their investment objectives from the onset and then stick with these Funds through cycles. At Seed, we are guided by a well-defined investment philosophy and rigorous process which means our fund and manager selection is in line with our long-term strategy. This ensures that our portfolios behave as expected, including periods of short-term underperformance. Sticking with such a strategy over the long term is key to attaining investment objectives.

Seed Weekly - The Great Exodus of 2017

The past month has been interesting, and not necessarily in a positive way.

A topic that has dominated discussions professionally and socially, for me at least, has been the increased desire of investors to invest a meaningful portion of their assets offshore. This follows a growing trend where assets under our care are steadily tilting towards hard currency global solutions as time wears on.
The reasons for this vary. The main theme recently has been a desire to hedge oneself from SA political & systematic risk.

When you look back to even a month ago, the risk of a political fallout has increased. Although we don’t think it is highly likely that we will see the country imploding in the next couple of weeks, the risk, in fact, is non-zero and thus does requires our dedicated attention.

In spite of this, we still believe that the most important reason to invest overseas should not be because of a state of nervousness, but rather due to portfolio diversification strategy. It is something we tout quite often as being fundamental to a successful investment strategy.

You may now ask if doing the right thing for the wrong reasons remains the right thing. I would say, ‘In a way, yes’.

The political risk that South Africans believe they face, correctly or otherwise, is that we are at a crossroad where either it all breaks down, or not. The stakes are high. The higher the stakes, the more harrowing the experience of having to live through the events as and when they occur. This is compounded by the fact that what a person stands to lose is the ability to call South Africa home, which is indeed a very emotional consideration. It is therefore very difficult to completely disregard these emotions when making investment decisions.

The problem with making decisions emotionally, is that it is always reactive. In order for your investment strategy to be successful, it is of utmost importance to remain proactive. Not in the sense of trying to predict the future at all, but rather ensuring that your asset & liability profile, remain aligned with a suitable strategy after considering the risks involved in the various options available.

We support the idea of having a healthy portion of your assets invested outside of the country, even if your liabilities are in Rand. By comparison, SA is a small country, and although there are a few very good companies with which one can invest, the universe remains small. There are many sectors that remain underrepresented on the JSE that can only be accessed in a global portfolio. That doesn’t even touch on the multitude of excellent investment companies and opportunities available beyond our borders.

We strongly believe that increasing the geographic breadth of your asset risk exposure is a wise move, all things considered. Doing so enables you to remove your exposure to SA systematic risk, though a few additional issues still need to be considered. While matching your assets and liabilities across different currencies are among the important considerations, ensuring that you have adequate diversification across asset classes should remain your primary consideration. Investing across multiple jurisdictions can also create additional considerations in the event of your death. However, with proper consultation and planning, these issues can be navigated.

The situation we find ourselves in at the moment is rather unique, and requires level headed thinking. Disentangling yourself from SA can be an expensive exercise, and needs to be considered in broader context - SA is not the only country that has risks and challenges, political or otherwise. The Seed Team is on board with developing and managing solutions to these risks, and has been for some time.

Looking at the big picture we recognize the influence of political risk. By its very nature, political risk is almost entirely unpredictable, and difficult to factor into our process. What we can say again, is that diversifying your assets is a good idea, as long as you have a proper plan in place and have considered the implications of selling SA assets and investing offshore.

As we bear witness to a great exodus of cash, I think we all hope that things work out for us; the question we should ask ourselves is not “Am I hedged against the apocalypse?” but rather to look at your balance sheet and ask, “Can this be improved?”.

Seed Weekly - Residential Property in the Western Cape - the Best of a Bad Bunch

South Africans like to own property. A secondary home, or even a holiday home, is no strange phenomenon in our country. The security of owning a physical asset that we can see and touch provides one with a sense of security and “wealth”. Property is personal and provides people with the ability to express their creativity and inspiration, something no other asset class can provide. Many South Africans also believe that property will always be a good investment.

As they say, “The proof of the pudding is in the eating”. Looking at the performance of the residential property market using the FNB House Price Index, it does not paint a pretty picture.

Graph 1 : Major 5 Regions House Price Inflation Rates (year-on-year)

Source: FNB Property Barometer, April 2017

The graph above, as at the end of March 2017, illustrates the slowdown in residential house prices. The Western Cape has been the darling of the residential property market since mid-2011, outperforming all of the other four major regions on a year-on-year basis. The year-on-year average house price growth for the Western Cape measured 6.2% in the first quarter of 2017. This is slower than the 7.7% rate of the previous quarter, and now considerably slower than the 10.6% multi-year high recorded in the first quarter of 2016. As illustrated in the graph above, there has been a significant decrease in residential property prices since early 2015.

Over the last seven years, homeowners have been struggling to find any real returns from their residential properties, as house prices have hardly kept up with inflation. There has also been a significant decrease in the demand for buy-to-let properties. According to First National Bank, transactions have decreased from a peak of 25% in 2008, to below 6% in 2016. Since the beginning of 2010, the average house price for the Western Cape has risen cumulatively by 78%. That is an annualised capital growth of roughly 8.5% over the past 7 years. By comparison, the next strongest growth was in KZN, with a modest 46%, and Gauteng with 41% over the same period. This amounts to an annualised capital growth of 5.5% in KZN, and just over 5% in Gauteng. Hardly any real capital growth, outside the Western Cape, if you consider an annualised inflation rate of 5.5% over the past 7 years. Alternatively, a property tracker fund tracking the SAPY would have returned 16.5% annually over the same period.

Graph 2 : Major 5 South African Regions House Price Increase since early-2010

Source: FNB Property Barometer, April 2017

As with all investments, there are also some risks to consider. Tenants paying late (or never), and an increase in interest rates, are some of the key risks that investors will need to consider before investing into a buy-to-let property. Rates and taxes have also been rising, on average way above the inflation rate per annum over the last few years.

Higher interest rates bring me to my next point: “What will the impact of South Africa’s credit downgrade be on the residential property market?”

As we are entering unchartered territory, we are not completely sure what to expect. However, one of the key risks of a credit downgrade, which can have a significant impact on the property market, is higher interest rates. With a potential increase in interest rates, investors will also have to deal with increased mortgage payments going forward.

Some will reason that the average house price index is not a true reflection of the property market segments, as suburbs on the Atlantic Seaboard in Cape Town, or Westcliff in Johannesburg, have seen annualised house price growth in double digits since 2010. This is certainly true, though these properties are the exceptions to the general property market in South Africa. It will require some thorough research to identify the right area to buy in and determine which types of properties are in demand to uncover these gems.

Property allocation is essential to a well-diversified portfolio, but taking the risks and returns into account, I would much rather place my allocation in listed property than residential property.